Deck 17: Understanding Accounting and Financial Information

Question 1

Why must accounting reports be prepared according to specific procedures (GAAP) Should we allow businesses some flexibility or creativity in preparing financial statements Why or why not

Answer 1

GAAP stands for Generally Accepted Accounting Principles. It is a set of guidelines or standards that the accountants must follow to prepare the financial statement.
GAAP should always be followed while preparing financial statements for the below mentioned reasons:
• The main aim of a financial statement is to inform the investors about the financial health. Therefore, to ensure there does not remain any manipulation accountants must use a specific standard which is outlined by GAAP.
• GAAP helps to eliminate the complexity of the financial statements and makes it understandable for all.
• Following the GAAP ensures comparability of the financial statement of a company. Any financial statements prepared by following GAAP can be easily compared intra industry or inter industry.
• GAAP helps to maintain the relevancy of information in the financial statement. Relevancy is important, as disclosing irrelevant items in financial statement can make it complex and unreadable for the investors.
Allowing creativity or flexibility in preparing financial statement would lead to various problems of
• Understandability,
• Reliability,
• Comparability , and
• Relevancy.
Therefore, the financial statement will be complex and unreliable. It will not depict the real financial position of the company an d will be of no use for the investors.

Question 2

Go to the websites of the American Institute of Certified Public Accountants ( www.aicpa.org ) and the Institute of Management Accountants ( www.imanet.org ). Browse the sites and find the requirements for becoming a certified public accountant (CPA) and a certified management accountant (CMA). Compare the requirements of the programs and decide which program is more appealing to you.

Answer 2

Requirements for becoming CPA:
The requirements for becoming CPA are:
• A total of 150 semester credits from a college or university whose accreditation is accepted by the state should be cleared by the candidate.
• A minimum of a bachelor's degree.
• A specified number of accounting courses.
• A specified number of business courses.
• A person will have to fulfill all the basic requirements mentioned above and then he/she will be a CPA.
Requirements for becoming CMA:
The requirements for becoming CMA are:
• The candidate should hold a bachelor's degree from an accredited university.
• He/she should have at least 2 consecutive years of professional experience in management accounting or financial management.
• He/she has to become a member of Institute of Management Accountants.
• He/she has to comply with the IMA Statement of Ethical Professional Practice.
• A person will have to fulfill all the basic requirements mentioned above and then he/she will be a CMA.
Out of the two courses the CPA course appears to be more appealing. The main reason stands to be the fact that CMA requires two years of experience.

Question 3

Potz and Pans, a small gift shop, has current assets of $45,000 (including inventory valued at $30,000) and $9,000 in current liabilities. WannaBees, a specialty clothing store, has current assets of $150,000 (including inventory valued at $125,000) and $85,000 in current liabilities. Both businesses have applied for loans. Click the Calculators box on the toolbar at www.bankrate.com and then click on Small Business to answer the following questions:
The acid-test ratio subtracts the value of the firm's inventory from its total current assets. Because inventory is often difficult to sell, this ratio is considered an even more reliable measure of a business's ability to repay loans than the current ratio. Calculate the acid-test ratio for each business and decide whether you would give either the loan. Why or why not

Answer 3

Acid Test Ratio:
It is a liquidity ratio that which is used for measuring the ability of the firm in meeting its short term liabilities through its short-term assets exclusive of the inventory, In other words the acid test ratio depicts the volume of short term assets that helps in meeting the nearby and immediate liabilities without the sale of inventories. However the ratio of 1:1 or more is said to be satisfactory while the ratio below of 1 is considered as unfavorable as it indicates that the immediate liabilities are more than the short term assets and require the sale of inventory also to satisfy the obligations.
Here in this instance if we observe the given financial data of "P and P" as well as "W and B" it is found that the current assets were inclusive of value of inventories. Hence prior to the evaluation of the acid test ratios of the both firms we need to define the current assets value excluding the inventory values and current liabilities for both the firms.
Data of "P and P":
Current Assets: $45,000
Inventories: $30,000
Current Liabilities: $9,000
Data of "W and B":
Current Assets: $150,000
Inventories: $125,000
Current Liabilities: $85,000
Now we will be evaluating the acid test ratios for the both the firms "P and P" as well as "W and B". The general formula that which is used to evaluate the acid test ratio is as follows:
With the substitution of the available data in the above formula as per the relevance we get the acid test ratio for both the firms as follows:
Findings and Conclusions:
From the above analysis it is found that the acid test ratio of "P and P" firm is higher with 1.67:1 than the ratio of "W and B" firm as well as the normal ratio of 1:1. This indicates that the liquidity of the "P and P" firm is higher depicting the higher capability of the firm in meeting its immediate and short term obligations. Hence the chances are more in granting of loan for "P and P" firm due to its satisfactory liquidity.

Question 4

What value do financial ratios offer investors in reviewing the financial performance of a firm

Question 5

Suppose you are a new board member for an emerging not-for-profit organization hoping to attract new donors. Contributors want to know how efficiently not-for-profit organizations use their donations. Unfortunately, your fellow board members see little value in financial reporting and analysis and believe the good works of the organization speak for themselves. Prepare a fact sheet convincing the board of the need for effective financial reporting with arguments about why it helps the organization's fund-raising goals.

Question 6

Why is it important to remember financial ratios can differ from industry to industry

Question 7

Obtain a recent annual report for a company of your choice. (Hints: The Wall Street Journal has a free annual reports service, and virtually all major companies post their annual reports on their websites.) Look over the firm's financial statements and see whether they match the information in this chapter. Read the auditor's opinion (usually at the end of the report) and evaluate what you think are the most important conclusions of the auditors.

Question 8

Obtain a recent annual report for a company of your choice (see the hints in exercise 4) and try your hand at computing financial ratios. Compute the current ratio, debt to owners' equity ratio, and basic earnings per share ratio. Then request an annual report from one of the firm's major competitors and compute the same ratios for that company. What did you find

Question 9

As a potential investor in a firm or perhaps the buyer of a particular business, would it be advisable for you to evaluate the company's financial statements Why or why not What key information would you seek from a firm's financial statements

Question 10

Contact a CPA at a firm in your area, or talk with a CPA in your college's business department. Ask what challenges, changes, and opportunities he or she foresees in the accounting profession in the next five years. List the CPA's forecasts on a sheet of paper and then compare them with the information in this chapter.

Question 11

Potz and Pans, a small gift shop, has current assets of $45,000 (including inventory valued at $30,000) and $9,000 in current liabilities. WannaBees, a specialty clothing store, has current assets of $150,000 (including inventory valued at $125,000) and $85,000 in current liabilities. Both businesses have applied for loans. Click the Calculators box on the toolbar at www.bankrate.com and then click on Small Business to answer the following questions:
Calculate the current ratio for each company. Which company is more likely to get the loan Why